Problem #56: I measure my financial standing by my income, although I’ve heard that your net worth is a better number.
What is your net worth? Do you know how to calculate it? Is it the best way to measure your wealth? Here’s a clue. Your net worth isn’t directly tied to the amount of stuff you have, the size of your house, or the number of cars you own, contrary to most commercials on TV.
Maybe you measure your status by the paycheck you bring home week after week. Bigger is better . . . right?
But your net worth is a better standard. If you don’t know your net worth, we have a PROBLEM.
The term “net worth” is defined as your assets minus your liabilities.
So to calculate your net worth, add all your assets together. Your assets include your checking, savings, and retirement account balances. Add in any other investment account balances. Also included are the values of any other things you own. Like your house, cars, rental property, boat, RV, or other “toys”. These are all included.
Do not include life insurance policies or expected inheritances. You don’t actually own these . . . yet. You may own them in the future, but not right now.
Now, start subtracting your liabilities. This is all your debt. Include credit card debt, student loans, car loans, and mortgages. Subtract any other debts also.
The number at the end is your net worth. Is it positive? Negative?
Why Your Net Worth Matters.
When you start to think of items in terms of your net worth, you paint a different picture of their value in your mind. For example, let’s think about your house.
You bought a modest house for $150k, and your current mortgage balance is $110k. So your equity in the house is currently $40k. Makes sense – right? This is the number that adds to your net worth. In other words, your equity adds to your net worth. The overall value of your house doesn’t matter . . . much, especially if you have a mortgage on it.
Note that this is why mortgages are normally considered good debt (if there is such a thing). They have an appreciating asset attached to them. The house is usually valued initially more than the mortgage balance, and the house will normally increase in value over time. In this case equity is always increasing. But not always . . .
Imagine if you owned a house that is currently valued at $450k, but your mortgage balance is $500k. You would actually have negative equity of $50k in your house. You would be underwater. This number would be subtracted from your net worth. Sadly, this situation is far too common for mortgages generated around 2007 and 2008. But note that this “loss” is only realized if you actually have to sell your house.
From the outside, you might envy the family living in the big half million dollar house. But what you may not know is their mortgage and other debts. This is why it’s so dangerous to compare yourself to others. The net worth of others can be invisible, because their debt is hidden.
What about Cars?
Cars are usually not considered an asset, as their value decreases over time. But their current value should be added into your net worth as you could sell them at any given time for their listed value.
This is why car loans are a terrible idea. In the beginning of the loan, you will owe more than the car is actually worth. This will be a negative number to add to your net worth. Just like a house, the impact to someone’s net worth from a car may be positive or negative. You can’t possibly know just from seeing them drive down the highway. Don’t compare your paid off Civic to their Corvette. You just don’t know the impact their car has on their net worth.Debt is sneaky. Income is flashy. Positive Net Worth is real wealth. Click To Tweet
What about Student Loans?
To start, student loan balances are always subtracted from your net worth. But this isn’t necessarily the whole story. Without your degree, you might be stuck in a dead-end job for most of your life. And your income may stay low, depending on your drive and ambition.
On the flip-side, student loans may enable your earning potential to be higher. The risk is that you incur substantial student loan debt with little to no income increases. For example, if you have $100,000 in student loan debt from your liberal arts degree, you haven’t done yourself any favors. Your earning potential may still be low.
But you could have $250,000 or perhaps even more student loan debt incurred while obtaining your M.D. or law degree. But your earning potential is much, much higher. You might be able to earn upwards of $200,000 – $300,000 per year or even more over time.
This is why student loans are an interesting discussion. It all comes down to the individual and their chosen degree. Note that many recent college graduates have an initial negative net worth due to student loan debt.
So what’s your net worth? I hope it’s a positive number. See how you compare to other Americans here.
If your net worth is over a million dollars – Congratulations, you’re a millionaire! Remember that you can have an annual income of $50k, but still be a millionaire.
Paying down your debt by $10k has the same effect on your net worth as saving $10k. It’s just not as glamorous. But don’t be fooled. Eliminate your debt as quickly as possible. Then you can start building your net worth, and becoming wealthy.
So do you know your net worth? How important is it to you? Let me know in the comments below.